CFTC Bitcoin fraud action shows authority over the crypto industry

The Commodity Futures Trading Commission (CFTC) has filed a civil lawsuit in the U.S. District Court for the Western District of Texas and charged Cornelius Johannes Steynberg and Mirror Trading International Proprietary Limited (MTI) (collectively, the defendants) with fraud and registration violations.^[1] The action claims that from May 2018 to March 2021, the defendants orchestrated a multi-level marketing plan to request bitcoin transfers from individuals to a centralized asset pool (pool) under the guise of offering investment opportunities.^[2] The defendants made these offers without any CFTC registrations of any kind.^[3] The CFTC claims that MTI should have been registered as an operator of commodity pool (CPO) while Steynberg should have been registered as an associate (AP) of MTI.^[4] This case is important not only because of the extent of the alleged fraud, but also for the CFTC’s claim of enforcement authority over the cryptocurrency industry in general.

MTI was publicly marketed as an opportunity for individuals to invest bitcoin in the defendants’ pool and earn profits from trading without a stock exchange.^[5] The CFTC has claimed that the defendants’ scheme has allegedly collected unwanted gains of at least 29,421 Bitcoin at an estimated value of over $ 1.7 billion.^[6] The CFTC further alleges that the defendants abused all the pool funds, making this enforcement “the biggest hitherto accused by the CFTC involving [b]itcoin. “^[7]

The CFTC’s enforcement authority over bitcoin was originally claimed in 2015 via In the question of: Coinflip, Inc., d / b / a Derivabit and Francisco Riordan when the agency first considered bitcoin as a commodity under the Commodity Exchange Act (CEA).^[8] In 2017, then-CFTC chairman J. Christopher Giancarlo publicly labeled bitcoin as “a commodity unlike any the Commission has dealt with before.”^[9] In June 2022, Gary Gensler, chairman of the US Securities and Exchange Commission (SEC), put extra responsibility on the CFTC when he stated that bitcoin is the clearest example of a cryptocurrency that meets the criteria for a commodity.^[10]

Although the CFTC’s authority over bitcoin and cryptocurrency has largely been accepted, this enforcement action provides an opportunity for the CFTC to formally strengthen its authority over bitcoin and the wider cryptocurrency area.

IN DEPTH

BACKGROUND

MTI was founded in 2019 under the laws of the Republic of South Africa.^[11] However, Steynberg marketed MTI’s pool globally and had allegedly engaged with people who were not qualified contract participants (ECPs).^[12] The CFTC claims “at least 23,000 [MTI] participants from the United States and around the world ”were tricked into contributing to the pool.^[13] Steynberg orchestrated this widespread deception by leveraging social media platforms, as well as other direct-to-consumer marketing strategies, to broadcast MTI as a ramp into forex trading opportunities where MTI participants could earn passive income through MTI’s collective trading. of its assets for retail currency on a geared, marginal or financed basis.^[14] MTI’s mild qualification thresholds allowed anyone over the age of 18 and with a minimum commitment of $ 100 in bitcoin to qualify as an MTI participant.^[15] MTI participants were led to believe that their bitcoin would be put into the pool and that trades facilitated by a “fine” would yield up to 10% in profits per month.^[16]

Although MTI participants were assured that they could withdraw all funds deposited within 48 hours of a request, it was later discovered that such a trade “fine” did not exist – nor were any of the alleged trades actually profitable. – and that all bitcoin transactions took place at defendant’s own discretion.^[17] The CFTC claims that the defendants tried to promote their deception by falsifying bank statements and by effectively operating a Ponzi scheme where main deposits from later MTI participants were redistributed to former MTI participants to give the illusion of “return”.^[18] The defendants further sought to expand the pool by establishing an “affiliate” program in which MTI participants were influenced to recruit friends and family members to register with MTI in return for bonuses on the platform.^[19] In reality, these new MTI participants also deposited bitcoin in MTI accounts centrally controlled by Steynberg and without actual trading activity to generate organic profits.

THE BEGINNING OF THE END

In July 2020, the defendants were issued a cease-and-desist order by the Texas State Securities Board (TSSB) after the TSSB found that Steynberg had made significantly misleading claims and that MTI’s operations were fraudulent.^[20] Then, in August 2020, the defendants lost access to their account with FXChoice, the primary broker intended to enable MTI’s currency trading. FXChoice had frozen the defendants’ account due to suspicion of fraud.^[21] At that time, only 1,280 bitcoin (valued at $ 56 million) existed in the defendants’ FXChoice account, even though the defendants had accumulated 29,421 Bitcoin during the duration of the scheme.^[22] FXChoice finally transferred the frozen balance to South African bankruptcy liquidators in April 2021 under an order from the South African Financial Sector Conduct Authority (FSCA).^[23] After FXChoice froze the defendants’ assets and refused to do any further business with the defendants, “Steynberg, individually and as an agent for MTI, represented to [MTI] participants that MTI would transfer all [p]ools trading accounts from FXChoice to an alleged online broker identified as Trade300. “^[24] Trade300 did not exist and does not exist.^[25] Although Steynberg had tried to escape South African law enforcement as a refugee, he was recently arrested by INTERPOL in Brazil.^[26]

CFTC ENFORCEMENT ACTION

The CFTC has alleged four points against the defendants under the CEA. First, the CFTC alleges that the defendants had participated in a fraudulent scheme involving unregistered foreign exchange trading.^[27] The first count includes illegal trading in commodity futures, the use of mail or other instruments for intergovernmental trading in connection with retail currency transactions, illegal foreign exchange transactions or marginalized currency transactions with non-ECPs, and that Steynberg himself exercised direct and indirect control over MTI either in bad faith or deliberately causing MTI to violate CEA.^[28]

The second count claims that Steynberg acted as an unregistered AP of MTI, which itself operated as an unregistered CPO by requesting, accepting or receiving funds or property from the public while engaged in a business with currency-based investment transactions.^[29] During this second count, each act of fraudulent solicitation, embezzlement and false declaration is a separate and obvious violation.^[30]

The third point alleges non-operation of a pool of goods as a separate legal entity, failure to receive funds in the name of the pool and a confusion of pool funds.^[31]

The fourth and final count claims that the defendants failed to register as a CPO or as an AP despite the fact that their continued operations qualified them as such.^[32]

IMPORTANCE IN THE DEVELOPING REGULATORY ENVIRONMENT

The mandatory adaptation of regulatory regimes to the public use of new technologies is a recurring theme in American jurisprudence. The regulation of cryptocurrency is no different. The timing of this enforcement action coincides with CFTC Chairman Rostin Benham’s public push to seek additional resources for the CFTC and marks a prime opportunity to demonstrate the agency’s capacity in regulating cryptocurrency markets.^[33] This enforcement action also coincides with the recently proposed Financial Innovation Act (FTA). The FTA is a two-part effort from the duo of Senator Cynthia Lummis (R-WY) and Senator Kirsten Gillibrand (D-NY) which aims to pass a federal bill that will establish railings around the cryptocurrency industry.^[34] The FTA proposes a categorization of cryptocurrencies that last, and brings cryptocurrency further into the CFTC’s authority.^[35] Weeks before Steynberg’s enforcement action, at the Chainalaysis Links conference, CFTC chairman Benham publicly reiterated the need for the CFTC to have additional authority to regulate cryptocurrencies.^[36]

Enforcement actions such as this present a concrete test of the CFTC’s ability to discipline and mature the cryptocurrency industry. At a time when cryptocurrency fraud seems to be everywhere, with more than 46,000 individuals losing a total of over $ 1 billion in 2021 alone, the CFTC has positioned itself as the police authority over this once designated “wild west” of an industry.^[37] The outcome of this latest CFTC enforcement action will not only affect the agency’s credibility among consumers, but it may also chart the course of how much power politicians give in the CFTC going forward.

Aristotle Mannan, a summer employee at the Boston office, also contributed to this article.